A surety bond is a financial tool used to provide a more expedient path of recourse for a party that is owed an obligation by another party. The party owed the obligation is the obligee. The party expected to complete the obligation is the principal. A surety bond provides a path of recourse for the obligee in instances where the principal does not complete the obligation as expected. A surety bond achieves this by placing the immediate financial responsibility on the surety backing the bond.
A surety bond has an attached monetary penalty that the surety is responsible for in the instance of a valid claim on the bond. The penalty amount may be set by the obligee, a government agency or other entity requiring the bond be posted by the principal. The amount is usually representative of the potential for loss to the obligee if the principal does not fulfill the obligation. The penalty amount may also represent an amount deemed sufficient to cover any fees charged to the principal for violations of specified laws, rules and regulations. The surety backing the bond is the party immediately financially responsible for the bond penalty in the instance of valid claims.
A surety bond differs from an insurance policy. Where an insurance policy pays out on valid claims without attempting to directly recoup the losses from the insured, a surety does not operate with the expectation of incurred losses due to claims, at least at the individual bond level. When a valid claim is made against a surety bond, the surety will attempt to recoup the expenses incurred from that claim. The principal is ultimately financially liable to the surety for the expenses incurred by the surety due to a valid claim on the bond.
Surety bonds are used to secure many different types of obligations. The main general categories for surety bonds are as follows: